The Tycoon Report

3 Winning Stocks... To Avoid!

Wednesday, October 31, 2007 | Chris Rowe

On Monday, Wayne Mulligan wrote an article that I loved titled "No Regrets".  The point was awesome, not because it was groundbreaking, but because while it was so obvious, it's one of those obvious points that humans naturally have a very hard time implementing in their investing lifestyle. 

Long story short, he talked about a private investment that his buddy tried to get him into that didn't meet the criteria that Wayne looks for to identify a quality investment with the right risk vs. reward ratio.  The value of the private investment (of course) multiplied tenfold in a short time, and, knowing this, Wayne still knew that staying out of it was not a mistake.  Of course it wasn't!  

The private investment might have seemed like a good one, but not a great one.

Now, when you think about it, you know that the people who did invest in that deal feel as though they are savvy investors.  You KNOW they feel like they did their research, and that skillful research panned out "exactly how they thought it would."  (Or were they merely sold on the idea?  Did they consider what they THOUGHT they should consider, even though it was the wrong thing to consider when investing in a private investment?)

What if the #1 football team were playing against the team in last place - and I bet my net worth on the last place football team because they had pretty, shiny helmets and because their quarterback was a Gemini - and then they won?  Was I smart for placing the bet?  Was my analysis correct?  More importantly, did the person who bet against me make a "mistake"?  Did my buddy who didn't bet with me regret not placing that bet with me?

Enough analogies. 

Like I said, I knew this would sound obvious to you, but the fact is that 90% of investors bet on shiny helmets.  What about you?  

Let's get into some current, real life examples.

"Most investors are lazy."  That's what many of the most successful investors think.  Legendary money manager Peter Lynch, who successfully ran the Fidelity Magellan Fund from 1977 - 1990, said that Americans spend more time choosing their refrigerators than they do their investment portfolios. 

Learning how to approach investing, and how to truly identify the most likely winners, isn't hard to do at all.  What's hard is to fight human emotion.  It's your nature to want to believe in positive outcomes. 

But that natural human trait can be disastrous.  

When you do understand how to identify the traits of winners, and more importantly how to eliminate potential trades even when they look good, it becomes harder and harder to find stocks that you are willing to bet on.  (And when I say "bet on", I mean profiting from up or down moves.)  If you find it easy to pick stocks, then you aren't screening hard enough, and your standards are not high enough.  Eventually, you will lose money in the market.

At Tycoon, I'm surrounded by readers who DO spend significant time on their portfolios.  They aren't "lazy."  I know that many individual investors request a lot of information.  The problem is, most people just don't know the best way to use that information.  Furthermore, the "story" might be appealing - in the news from the company, in analysts' reports - but if it's an unhealthy company from a technical perspective, then it's not worth putting your money into.

Let's look at today's market and consider some of the most popular stock ideas, and why they shouldn't be on your shopping list. 

Today's Market

First of all, we must consider whether we even want to be in the market at all right now. 

- Are you willing to profit from downside moves, or do you need a bull market? 

- Consider the current Monetary Policy.  It's viewed as positive for the market currently, as rates are being lowered. 

- Pre-election years are typically the strongest in the four-year market cycle. 

- Are we in the stronger months of the year?  We are now in what is typically the strong season for the stock market. 

- Is momentum positive or negative?  Is it increasing or decreasing?

All of these are factors to consider, among others. 

For the most part, the market looks somewhat positive right now.  I definitely wouldn't call it a grand slam (like the bottom of the correction was).  I do have concerns about the NYSE internals, as members of The Trend Rider know.  I don't see strength in the NASDAQ internals either, as TTR members also know.  The NASDAQ currently looks stronger than the NYSE which can be viewed as a positive sign.  But in a market that is showing internal weakness, we have to consider bearish trades, and we have to be VERY selective about our bullish positions. 


In the chart above, we see that the NYSE found support right where it was supposed to - at the old resistance level.  A very bullish chart pattern developed on that day exactly (green circle above).  We are starting to gain momentum again, but as of now, we must consider that we are on a MACD sell signal.

In the chart below, we can see that the NASDAQ composite did break out once again to another six-year high.  The volume wasn't impressive, and we are still on a MACD sell signal, but the first MACD sell signal can be overlooked (on both the NASDAQ and NYSE) because we are in a strong uptrend.  (Trust me on that.)




My rating on today's market is officially: "eh".  But the positives regarding the four-year cycle, combined with the seasonality factor, are strong considerations.

We must always consider the long-term picture, and where we currently stand relative to it.  We could easily pull back here a bit, even though this is typically the best time of the year.  It's not exactly a "perfect storm".


Second, we must consider that stocks that are in the same sector act in unison.  Sectors (or peer groups) also act like different mini stock markets within the general market, moving in different directions with different levels of risk and strength.  We want to take bullish positions ONLY in the stocks that are in the strongest sectors of the market.  If we take bearish positions, we ONLY want to be in the weakest sectors.

Third, we also must consider that the strength might currently be in the Small-Cap Value, Small Cap Growth, Mid-Cap Value, Mid-Cap Growth, Large Cap Value, or Large Cap Growth group.  This is easy to figure out.  And when we identify the characteristics of certain sectors, we'd rather focus on sectors that are in the favored group.

CHEAT NOTES:  Currently, Mid-Cap Growth is the place to be (Mid-cap companies having a market capitalization between $2 billion and $10 billion).  Large-Cap Growth is also doing well, so it takes second place (Large-Cap companies having capitalization usually between $10 billion and $200 billion).

Do you consider all three of these before even considering signing on to your online brokerage account?  They're each very small, easy and important steps.

Now, I personally have layers and layers of considerations and screens when it comes to finding trades.  I narrow it down and narrow it down, often until I'm left with NOTHING to trade. 

It's the gift and the curse.  (A "curse" because it's nearly impossible to find the "perfect" trade.  A "gift" because when I do find the trades that are clearly identifiable as excellent, I have enough confidence in the position to take a real position - meaning I can comfortably put a significant amount of money behind it.  It's when I know I've got a winner.) 

This may sound surprising, or even hard to believe, but all of these "layers" are very simple for the average Joe or Jane to understand.  How do I know that?  Because I've witnessed the growth of a lot of Joes and Janes who are now really good investors after spending just a little bit of extra time at it! 

All that one has to do is spend a little bit of time learning what to look for, and once you do that, the knowledge can never be taken away from you.  Every new indicator that you understand increases your odds of success (and your ability to know why and when you need to eliminate possible trades from your potential trade list).

Always assume that you just might be wrong about your trade.  It might be for a reason as simple as the general stock market turning around.  If the trade goes the wrong way, you want at least 80 - 90% of the reasons for making the trade to still exist.  If your bullish trades move lower, and you have 10 or 20 different bullish arguments that you can make based on some very simple indicators, then they are likely to bounce back with a vengeance when the market resumes its uptrend.  And if the market continues lower, these are the stocks that will be hit the least, which is very important.

In the following examples, I'm just going to consider a few of the indicators or factors that jump out at me.  Let's start eliminating!

Google Inc. (Symbol: GOOG)

Definitely a growth stock.  The market cap is $220 bil, making it a bit more than a large-cap.  (Remember, we prefer mid-cap growth, and large-cap growth takes second place.)

Google Inc. recently crossed the $200 bil level, making it a "Mega-cap."  I'd rather be in a Mid-cap growth stock, but this one is still okay.  The Internet sector (which is Google Inc.'s peer group) is very strong.  It's showing positive relative strength vs. the market, and Google Inc. is outperforming the sector.  These are criteria that I am happy with.  In fact, with the increasing momentum, I wouldn't be surprised to see this stock trade higher!


But this isn't a good buy.  Just because it looks like it will likely trade higher, doesn't make it a good buy.  You want to buy stocks when several buy signals are seen.  Green arrows and blue circles show when buy signals were given.  The stock has climbed about 200 points since the ideal buying point for this stock. 

I also see a red flag here.  The volume isn't very impressive (red and green vertical lines).  With the stock breaking highs like this, I'd prefer to see volume increasing tremendously on up days.  But this volume is only slightly above average.  And on recent down days, we see strong volume.  Not what you want to see in a stock that you want to move up.


When I look at the RSI, I see that the stock is overbought.  Now don't get me wrong, it can stay overbought for a while, and it could trade over $1,000 and still be overbought.  (In fact, the stock moved into overbought territory by RSI standards about 150 points ago.)  But I don't want to buy a stock that's overbought.  It's also above the top of its trading band.  I like to buy stocks (or call options on stocks) that are in the early breakout stages. 

Google's quarter over quarter earnings and revenue are also decelerating.  That means that while the company is growing, it's growing at a slower and slower pace.  Here's what they look like:


While this stock looks good, it doesn't warrant a purchase.  If the stock trades to $2,000.00 in six months, it is still currently the right choice to stay out.  Not just because of the decelerating numbers, but for all reasons mentioned.  But just to take this one part of the example:  If the general market moves lower, dragging most stocks down with it, the stocks with accelerating quarter over quarter numbers (as opposed to decelerating) are much more likely to be the strongest, and lose the least amount of value.  They are also the most likely to be the leaders when the market rebounds. 


Exxon Mobil Corp. (Symbol: XOM)

A Growth stock, and certainly a Mega-cap, Exxon's market capitalization is over $500 bil.  I would rather own a smaller company right now.  Maybe you see that oil is moving closer to $100.00, and since interest rates are dropping, and the dollar is weakening, and crude is priced in US Dollars, the stage is set for higher oil prices - theoretically, anyway.  So you turn to Exxon Mobil because you know that they are the "big dog," and they have an enormous amount of cash and earnings.  You know that the oil sector is outperforming the S&P 500.

But here are the problems:

The stock is underperforming its peers.  So I would look for other candidates if I wanted to be in the energy sector.  Why be in the weaker stocks in the stronger groups? 


The stock made higher highs in the intermediate trend from July to October while the MACD and RSI made lower highs.  The stock made higher highs in the short term (from late September to early October) while the MACD and RSI made lower highs.  The MACD even shows a sell signal here.  These signals are enough to not only keep me out of the stock, but to tell anyone who owns the stock to sell it right now (unless you are a multi-year holder).

That right there is enough for me.  I don't really have to look any further.  I don't care if they have the most incredible story ever.  I don't care if they announced last month that they just found a bazillion barrels of oil.  That's right, folks - a BAZILLION.  (What's up with the negative divergences?  Why is the stock showing weakness?)

Another thing I want to point out:  The head and shoulders top formation.  Some of you know what this is, but I'll keep it simple and say it's a very bearish pattern, rarely seen, but very potent.  If the stock closes below the blue line, the stock will likely trade to $86.00, at best.  

SIDE NOTE: This stock carries the most weight in the S&P 500 and is one of the heaviest weight holders of the Dow.  So what's interesting is if that silly little blue line that I drew is broken by Exxon Mobil Inc. with a closing stock price that's lower than that blue line, the stock market as a whole would very likely pull back, or have a very hard time moving up.  Exxon Mobil Corp. also weighs heaviest in the ETF "XLE", so similar things would happen to that ETF.

I've pointed out several negatives.  But this would NOT make it a good candidate for a bearish trade.  When I look to profit from a downside move in a stock, I want many odds (to the downside) in my favor as well.  And as you can see, this stock is not only in a strong sector, but it's in a long-term uptrend. 



Apple Computer (Symbol: AAPL)

The sector is showing positive relative strength vs. the market.  Not the strongest sector we can be in.  Not even in the top 10.  But still a sector that's outperforming the market - Check.

Stock outperforming the sector - Check.

Definitely a growth stock - Check.

Large-cap (with a $165 bil Market cap - second place of preference to Mid-cap growth, but acceptable.) - Check.

Uptrend - Check.

So far - So Awesome!

The stock just broke out with what we call a "window" which is commonly referred to as a "gap" higher.  This is a continuation pattern if done so on heavy volume. - Check, Check Check!


The stock is overbought.  I would like to BE IN the stock right now.  I certainly wouldn't be a seller.  But this doesn't appeal to me as a good NEW position.  Again, I like to buy in the early breakout stages.  The "Doji star" is a very bullish pattern that would have been a good time to buy.  The MACD buy signal was appealing.  The recent activity is very comforting if you own it. 

I would like to see this stock regress back to the mean, or at least trade sideways to let the moving averages catch up.


After showing this much strength, with solid fundamentals, I would keep AAPL on my radar.  Perhaps if the market pulls back, this would be a good candidate.  But I'll have to evaluate that situation when it comes.  (A common mistake is to find the stock appealing today, then wait for a pullback, and buy it without starting over with the examination.)

The moral of the story...

Any of these stocks can triple over the next three months, and I would pretend it didn't bother me.  LOL!!  Just kidding.  It wouldn't bother me one bit.  I've seen this happen millions of times. 

The fact is that, today, they weren't the best bet possible.  And it's SO hard to find the best bet possible when you have 20 reasons why you might potentially avoid any given stock.  I may pick stocks that have something wrong with them simply because it's so incredibly hard to find the perfect idea.  And I'm criticized on occasion when I don't make recommendations due to the fact that nothing looks GREAT to me.  But with experience, the same people who criticized me have often written a future email confessing that they are starting to understand my patience.

After understanding what pieces of information are the most important when it comes to stock picking (which is something that anyone - I repeat: ANYONE can do), the absolute most important thing that you need to do when it comes to investing or trading is to have very high standards and be willing to sit on the sidelines until you have a trade that fits all, or at least 95% of the winning criteria.  NOTHING else is worth your hard-earned investment capital.  THAT is how people get to be worth $100 million.

The outcome has nothing to do with whether you were right or wrong in your decision to trade or not.  NOTHING!

If you remember that, and really understand what that means, then you are ahead of most individual and most professional investors.


“Profit from the Trend”

Chris Rowe
Chief Investment Officer
The Trend Rider